Did you know Debt Service Ratio (DSR) is the No 1 reason CEO and professionals get into severe debt problems? Don’t believe that high-income earners get into debt problems?. This is a common misconception or question I’ve gotten when I hosted a webinar two weeks ago.
First, let me tell you a real story….
Hi, my name is Ka Hoe and I’m the founder of J Advisory. So the story goes like this. There was a doctor who went to see AKPK’s officer. For those of you who don’t know what AKPK is, they are people you see when you need to overcome your severe debt problems. They offer free credit counselling advice to you.
So this doctor who earns a very good income of RM 50,000 a month needed help on managing his debt. With that kind of income, the AKPK officer was surprised about what kind of debt could he possibly have. Even the AKPK officer would want that kind of income and did not expect the doctor to have any problem.
“I can’t repay my credit card debts, personal loan & housing loan of RM 80,000 a month“, the doctor said. The officer almost fainted. He muster enough courage to ask “How (in the world) did you get yourself into paying RM 80,000 a month in loans?”
“Ohh, I bought 2 properties side by side because my friends told me I would make money if I invested in properties. So I bought 1 to stay and I bought the house next door to invest”, the doctor said. “And I love cars since I was a boy, so I bought a Mercedes & BMW at the same time. All my friends also have 2 cars”. The officer’s jaw drop.
How many of you have the same thought, that when you earn a high income, is almost impossible to have such a severe debt problem of negative RM 30,000 a month? Don’t you find it weird, that you thought only low-income earners had money problems? High-income earners shouldn’t have any money problems, right? Wrong!
Secondly, let me break it down for you.
Let me explain. Why do high-income earners have a high debt problem? This is a common thing that I’ve seen in my past 12 years of experience helping people plan their financials. I have helped many high-income earners turn around from depression to have healthy savings. One of the biggest problems is due to this thing called Debt Service Ratio.
This is a calculation the bank uses to measure how well you can pay your loans? So for example, if you have a Debt Service Ratio of 80%, basically it means that the bank will allow you, take up to eight thousand per month instalment when you earn RM 10,000 per month earning. As crazy as it seems, it is true. Refer to this picture below
This is one of the sample guidelines by 2 banks in Malaysia. As you can see the higher your income, the higher the percentage allowed for loan repayments. The lower your income, the bank assumes you have a significant amount spent on necessities & needs. Hence you would have a lower disposable income, with lower savings.
Compare this to someone with higher income (for eg above RM 10,000/month), they would spend more on necessities but the proportion would not be the same as a low-income earner. Hence a higher disposable income and higher savings should be able to pay more loans. This is the reference point made by all the banks when developing their guideline.
Of course, the banks have different grading and different calculation for different types of employment. For example, it is very different for somebody who is an employee or CEO working for a multinational company compared to someone working in his own business from a small and medium enterprise.
Thirdly, let me share the formula with you
So once you understand this, then hence you understand why high-income earners, are able to borrow more money. Let’s understand how to calculate Debt Service Ratio.
It is very simple to calculate your Debt Service Ratio. Referring to the picture above, first, you need to total up your ‘Total Debt Repayment per month’ for all your owings. If you need a tool, we normally use this Debt Management Template in our classes. You can download it HERE. Next, you need to get your ‘Net Income’. Net Income is defined as
‘Your Gross Salary‘ minus off ‘Your EPF, Socso, EIS & PCB‘
Then divide both numbers and multiply by 100. The higher the percentage, the higher the commitment you have.
You want to use your own numbers. You can refer HERE to a blog I wrote recently on how to get your credit report for FREE without leaving the comfort of your home.
So, how do you get out of debt faster now that you understand DSR?
DSR is similar to a double edge sword. If you don’t know how to use it, it can harm you but if you know how to use it, you can use it to your advantage. I wrote a blog on how I help James save RM 10,000 a month despite him having a deficit of RM 18,000 a month. Read to understand his background first and see if you could guess how we use DSR to get more loans despite having a deficit.
So let’s understand James’s DSR first. Refer to the picture above.
Why do most people miss this option on solving their debt problem which James uses? It is because most people think their DSR is already ‘koyak’ (does not qualify) if you refer to this picture below.
But in actual fact, this is an assumption. The key point on how to use DSR here, to get him a lower interest loan even though James is in deficit is, banks are only able to calculate his DSR if it appears on James’s credit report (CCRIS).
So when you look into his DSR calculation above, there were 2 loans that were not in his credit report (CCRIS), namely the ‘Company Loan’ & ‘Creditor A’. Notice his DSR is only 58% (above) as compared to what everyone assumes his DSR at 113%
Lastly, tell me what you think.
So, is that a good thing? Let me know in the comment section do you have a similar assumption as well before reading this blog? Now that you are clear on how to use DSR you need to borrow responsibly, especially during this covid period. We’ve started to help a lot of people who over-leveraged especially when they got a pay cut. It is a very painful experience especially going through this difficult period.
I’ve been there and I went through that hardship. I want to be able to reach out to you guys. If there’s any help that you need, follow us at J Advisory, where we specialize in helping people turn around their finances. Let me know if there’s any other misconception that you heard before. I’ll be happy to clarify it for you. Stay safe stay positive. Take care guys.